Commentary: The irrational-exuberance indicators are there for all to see

At a time when the 23-year-old CEO of Snapchat, a two-year-old company with no revenue, turns down a $3 billion buyout offer from Facebook, and when Twitter makes a spectacular debut, many people are reminded of the heady days of Internet stocks in the late 1990s and early 2000s.

Yet the analogy is misleading, according to the leading academic studies of investor sentiment.

The authors of those studies are finance professors Jeffrey Wurgler of New York University’s Stern School of Business and Malcolm Baker of Harvard Business School.

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A trader blows a bubble while working on the floor of the New York Stock Exchange moments before the closing bell.

One implication of their research is that it is important not to rely on our memories when comparing different periods’ sentiment levels. Not only are our memories short, we also tend to rewrite history to make the past appear different than it really was.

If you are basing your investment strategy on swings in investors’ mood between bearish and bullish extremes, it pays to rely on objective measures and a long-term perspective.

Messrs. Wurgler and Baker developed five indicators that were well correlated with periods of speculative excess over the past 50 years. None of them currently is detecting the levels of exuberance that prevailed at the top of the Internet bubble. They include the following:

1) The number of IPOs. Two of those five measures relate directly to the new-issues market. The first is the number of recent initial public offerings. Over the first three months of 2000, according to data from University of Florida finance professor Jay Ritter, there were 123 IPOs. By contrast, there were just 73 IPOs in the three months through Nov. 14.

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2) IPO returns. The average first-day IPO pops are also lower now. In the first three months of 2000, the average first-day return was 96%; now, it’s 25%, per Mr. Ritter’s data. Both IPO numbers are far short of what was seen at the top of the Internet bubble.

3) The dividend premium. An even bigger contrast in sentiment between today and early 2000 appears in what Mr. Wurgler refers to as the “dividend premium,” or how much investors are willing to pay for the relative safety of established, as opposed to speculative, stocks. That is a useful indicator, he says, because investors become relatively bored with established companies during periods of speculative excess.

To calculate this dividend premium, he categorizes dividend-paying stocks as “established” and those that don’t pay a dividend as “speculative.” To compare valuations, he focuses on the price/book ratio, which is calculated by dividing a stock’s price by its per-share book value, or net worth. Higher ratios indicate richer valuations.

Of course, not all dividend-paying companies are safe, and not all nonpayers are speculative. Nevertheless, Mr. Wurgler says that, historically, the difference in the two groups’ valuations has been a good barometer of investor sentiment.

At the top of the Internet bubble in early 2000, according to Messrs. Wurgler and Baker’s research, speculative companies had a 43% higher price/book ratio than established firms, on average. Today, it is just the reverse: Among the companies in the S&P 1500 index, according to FactSet, established stocks have a 49% higher price/book ratio than nonpayers, on average.

4) Share of new corporate cash from issuing stocks. The fourth sentiment indicator focuses on the percentage of new corporate cash coming from stock issuance rather than from longer-term debt that matures in more than one year.

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